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The C h allenge to the D ollar in a Changing W orld*
By A l f r e d H a y e s
President, Federal Reserve Bank oj N ew Y ork

In the past few months Americans have felt a sense of
national emergency such as they have not experienced since
World W ar II. Worst of all, crises have occurred on several
fronts at once— in our military and political stance in the
F ar East, in our efforts to make democracy at home a mean­
ingful way of life for all Americans regardless of color, and
in confidence in the dollar as the world’s most important
reserve and trading currency. Of course to a considerable
extent all three crises are related. However, I propose to
concentrate my attention today on the crisis of the dollar—
to sketch briefly how it occurred, what steps have been
taken to meet it, what misleading and dangerous proposed
remedies must be rejected, and what kind of measures we
must take to maintain the dollar as the key currency of the
international financial structure. I hasten to add that my
solicitude for the dollar is not based on some mystical wor­
ship of our currency as such, but rather on a recognition
of what a vital role it now plays in the world and of what a
tragedy it would be for the future course of international
trade and investment, as well as for our domestic economy,
if the dollar were no longer to command the world’s con­
F or too long we have tended to take for granted the dol­
lar’s impregnable position, based as it has been on the
tremendous strength of the United States economy and on
our dominant world role in the early postwar years. So great
was this reservoir of strength that we could run huge
balance-of-payments deficits year in and year out for ten
years, aggregating some $27 billion, and still the dollar re­
tained much of its earlier reputation. Americans were often
told that these steady deficits were undermining the dollar,
but somehow they couldn’t quite believe it— at least not
enough to do something really effective about it. To be sure
there were frequent official statements of determination to

*An address before the New York Chamber of Commerce cel­
ebrating its 200th anniversary, New York City, May 2, 1968.

move toward equilibrium. And temporizing measures were
adopted from time to time, designed mainly to check out­
ward capital flows while more fundamental remedies were
being worked out. F or a while, until the Vietnam escalation
of m id-1965, we were making considerable progress toward
a larger trade surplus and reduced military outlays abroad;
but that event put a quick stop to the improvement, brought
a sharp jump in foreign military expenditures, and set in
train inflationary tendencies that are still accelerating and
that have already been instrumental in cutting our trade sur­
plus to a dangerously low level.
In the political, military, and economic spheres we ap­
peared still to be working on the assumption that we could
take on substantial commitments throughout the world
without paying close attention to our ability to finance such
spending through exports and other earnings. This may
have been valid enough right after World W ar II, but cer­
tainly did not remain so. The fact is that in the intervening
twenty years the spectacular recovery of Europe and Japan
had radically reduced our dominance as an exporter and
that our annual outlays abroad, such as those for direct
investment and tourism, had grown to a very large size.
Small wonder that in these circumstances payments equilib­
rium remained as elusive as ever.
We had only to look to the United Kingdom to see how
costly it could be to disregard the inexorable pressures of
the balance of payments. In their case continual financial
crises reflected essentially an unwillingness to recognize the
full implications of the vital need for internal discipline and
increased productive efficiency. Although our much greater
economic strength is one of several major differences be­
tween this country and the United Kingdom, the November
devaluation of sterling flashed a clear warning for the
United States that we cannot ignore.
It had long been apparent to many of us that the fate of
sterling and of the gold m arket were very closely linked in
terms of market psychology and that sterling devaluation
could easily trigger a severe run on gold. Such a major
breakdown in the exchange-parity network was bound to



lessen confidence in all other currencies and especially to
raise new doubts as to the relationship between gold and
the dollar.
As expected, a violent eruption in the London gold m ar­
ket occurred immediately after the devaluation of sterling.
It was effectively countered at first by a statement issued in
Frankfurt of solidarity of the major central banks and of
their determination to defend the existing exchange struc­
ture with all means at their command. Another flare-up in
December was calmed only after a similar statement and
an assurance that the United States intended to take effec­
tive steps to bring its payments much closer to balance. The
latter promise was reinforced by the President’s balance-ofpayments program announced on January 1. But while this
had an important calming effect for several weeks, there
was a growing feeling among close observers of the gold
m arket that the gold pool— which meant in large part the
United States— could no longer afford to continue to feed
in monetary gold on the scale required to prevent the Lon­
don price from exceeding $35.20. It had become more
and more obvious that the major countries would not and
should not deplete their monetary gold stocks further to
supply a huge demand of individual and corporate gold
buyers all over the world, especially when citizens of the
United States, the United Kingdom, and several other coun­
tries had long been forbidden to own gold. All these pres­
sures came to a head in the record market flare-up of midMarch, to which the temporary closing of the London
m arket with the accompanying termination of the gold
pool was the only reasonable answer. In my judgment it
would have been far better if these actions had come some
months earlier. With reaffirmation in the M arch 17 Wash­
ington communique of international support for the $35
official price, coupled with establishment of the so-called
“two-tier system” and recognition of future supplies of
special drawing rights (SDR’s) as a new reserve asset, the
worst exchange m arket fears quickly subsided. The market
has remained generally quiet since that time, although an
underlying feeling of deep concern persists because needed
fundamental measures have not been taken.
In that hectic weekend of M arch 17, before the Wash­
ington communique was released, American travelers all
over the world had for the first time the traumatic experi­
ence of seeing the world really question the soundness of
the once unquestioned dollar. F or a day or two, dollar
traveler’s checks and dollar currency often proved impos­
sible to change into local foreign currencies, except perhaps
at a sharp discount. For those Americans involved, this
experience may have done more than any other recent event
to awaken them to the seriousness of our payments prob­

The two-tier system adopted in M arch in essence repre­
sented a decision to accept the inevitable consequences of
a distorted gold supply-and-demand position by separating
the circuit of monetary gold transactions from all trading in
gold as a commodity or speculative vehicle. Those who
doubt whether it is viable should, I believe, bear in mind
that, before the London m arket was reopened in 1954, free
prices for gold far above $35 often prevailed in local m ar­
kets in other countries without casting any doubt on the
firmness of the official $35 price. In October 1960, after the
run-up to $40 an ounce in the London gold market, there
was a deliberate tactical decision by the American author­
ities to prevent the London price from going above $35.20,
which was roughly the United States official selling price
plus shipping charges to London. The decision was almost
universally supported by opinion abroad, and this interna­
tional backing was formalized with the organization of the
gold pool in 1961. However, we should remember that it
was never an essential feature of the gold exchange stan­
dard. The pool had been a substantial net buyer of gold over
its entire life up to the time of the sterling devaluation of last
November. But when the cost involved very large inroads
into monetary stocks, the time had come to terminate it.
The question “Is the two-tier system viable?” merely
masks a more fundamental question, namely, “Will the
United States at long last take the steps needed to bring its
international payments somewhere near equilibrium?” If
not, we face dire consequences, and not because of the twotier arrangement or of a fault in the gold exchange standard
itself. No international monetary system can be devised that
is strong enough to withstand persistent abuse by the world’s
major industrial nations. By the same token it is utterly
misleading to suggest that we have viable alternatives, such
as raising the price of gold or embargoing gold payments,
to doing what must be done with our balance of payments.
Either of these moves would, in my judgment, have disas­
trous results in and of themselves. Yet neither one would
relieve us of the burden of adjusting our international pay­
ments. It is a sad commentary on the present state of affairs
that such proposals have moved out of the academic area
to open discussion in financial circles.
Increasing the price of gold would, temporarily at least,
cause chaotic conditions in the exchange markets, with a
consequent check to trade and investment flows that foster
economic development. After the initial confusion there
would be a period when each country would weigh the ad­
vantages and disadvantages of fixing a new rate for its own
currency in terms of gold and the dollar, a rate that might
or might not coincide with the view of the United States. We
would then face the danger of a series of competitive de­
valuations, as countries sought to assure the safety of their


trade balances. There would be a strong prospect for moves
toward trade protectionism, capital restrictions, exchange
controls, and other forms of retaliation. In the best of cir­
cumstances, it is difficult to see how we could preserve the
present momentum toward attaining a more rational system
of international liquidity centered on the SDR’s and the
various forms of international credit laboriously built up in
the last twenty-five years. We would instead be taking a
backward step by tying future reserve creation more or less
permanently to the vagaries of world gold production.
And that is not all. A change in the gold price would
constitute a gross breach of faith with all those monetary
authorities who have held dollars as an im portant compo­
nent of their monetary reserves. It could do irreparable
damage to future confidence in the dollar as a reserve cur­
rency and perhaps also to future use of the dollar as the
chief vehicle currency for world trade and investment. It
would reward disproportionately and— economically speak­
ing— irrationally the countries with large gold production
or large gold hoards, public or private. From a selfish
United States viewpoint, it would cause a major decline in
our political influence. Finally, years would be needed to
convince speculators that the new price could last. Since
a revaluation of gold would produce very large windfall
profits for gold-holding countries, and since it may be
doubted that politicians would be slow to spend such profits,
the speculators might have ground for thinking that con­
tinued inflation would before too long create the need for
a new revaluation.
Just as bad, if not worse, would be a move by the United
States to embargo further sales of gold for monetary pur­
poses. In the past few years some Americans have ad­
vocated the use of a threat of embargo to force foreign
acquiescence in our financial policies. I think it may be
well to remind them that an embargo could prove fully as
harmful to the United States as to our foreign partners.
Cutting the dollar loose from gold would probably lead
promptly to a chaotic system of floating rates in which all
trade and credit operations would be severely handicapped
and in which each country might feel forced to engage in
competitive restrictions on trade and payments. Quite pos­
sibly the major European countries would then form a
bloc adhering to their present parities in terms of gold,
while another group of countries would adhere to the dol­
lar. In this case the dollar might well float in relation to the
European bloc, with highly adverse effects on trade and
credit relationships similar to those resulting from a gen­
eral condition of floating rates. In either case the European
countries might decide to restrict severely American capital
inflows, or American imports, or both.
M ore generally, it would be illusory to expect that a


United States gold embargo would somehow lead to a
worldwide demonetization of gold and thereby open the
route to a new and more effective system of international
payments. Because of their large stake in monetary gold,
the European and certain other countries would probably
look to gold as the ultimate means of payments settlement
and, if any semblance of order in the exchange markets
were ultimately to be restored, the United States would from
time to time need to pay out gold in settlement of payments
deficits. Meanwhile, moreover, inter-central-bank and inter­
governmental credit facilities would have been severely
damaged, if not totally immobilized, while the current
bright prospect of opening up a new source of interna­
tional liquidity in the form of special drawing rights on
the International M onetary Fund would have suffered a
serious, or even fatal, setback. The paradoxical con­
sequence of a United States gold embargo, therefore,
might be eventually to restore gold to unchallenged pri­
macy in international settlements by undermining, if not
actually destroying, all the other supplementary means of
settling payments balances that have gradually developed
since the Bretton Woods Agreements.
I hope no one, therefore, will look to either a gold em­
bargo or a higher gold price as an acceptable escape route
from the measures of internal discipline that are needed
if we are to avoid chaos in international financial condi­
tions. What are these measures to which we must look for
a way out?
First and foremost, of course, we must slow and ulti­
mately arrest the dangerous upward sweep of costs and
prices that has been characteristic of the economy since
the Vietnam escalation of m id-1965, but which has ac­
celerated in the past nine months or so after a temporary
lull in early 1967. No one can look with equanimity at
the first-quarter 1968 rise in overall demand at an annual
rate of 10 per cent, with two fifths of this increase merely
resulting in a 4 per cent surge in prices. I recognize that
there are a few sectors of the economy, particularly some
manufacturing fields, where there is relatively little evidence
of overheating. But these are clearly exceptional. Skilled
labor is extremely scarce in most parts of the country, and
the intolerable size of recent wage increases bears testi­
mony not only to this labor scarcity but also to industry’s
ability and willingness to grant these increases and to la­
bor’s desire to offset the climb in the cost of living during
the last couple of years. In the absence of adequate fiscal
and monetary restraint, there is every reason to look for
continuation of this condition of excessive demand and
grossly excessive wage and price increases, which can set
the stage for recession in which both wages and profits
would shrink.



Besides sowing the seeds of future recession and pro­
ducing a multitude of domestic inequities, the current in­
flation is doing untold damage to the United States balance
of payments by sucking in imports at a very rapid pace
and by making United States exports less and less com­
petitive in world markets. The influence on imports has
been spectacular in recent months. After leveling off in
the first ten months of 1967, imports shot upward, and
from October through M arch have been running 15 per
cent above the same period a year earlier, far above the
growth in our exports. This is in keeping with experience
over a considerable period of years which shows that total
imports are extremely responsive to major swings in gross
national product.
Under the conditions I have outlined there is no con­
ceivable excuse for a Federal budget operating at a deficit
of $20 billion or more per annum. There is no mystery as
to the kind of fiscal action that is vitally needed to meet
this problem. A n income tax surcharge of the magnitude
proposed by the President, together with the strictest re­
straint in spending, would seem to be the minimum that is
called for. It would undoubtedly have a pervasive cooling
effect throughout our overheated economy. The effects of
an income tax rise are bound to be spread more evenly
than those, say, of a restrictive monetary policy. Unques­
tionably there are many types of spending that could be
sharply reduced without loss to the nation, but in some
areas, such as urban spending, substantial increases rather
than cuts are necessary.
I find it impossible to explain satisfactorily to foreign
holders of dollars why this obviously necessary fiscal step
of increased taxes plus reduced spending has not yet been
taken despite almost a year of discussion and strong en­
dorsement by most economic experts. I can think of no
more effective way of giving an enormous psychological
boost to the dollar than by providing at long last this
evidence of fiscal responsibility. Such an invaluable divi­
dend would of course be over and above the obvious
domestic benefits in the shape of a less hectic and less
inflationary growth rate.
M onetary policy has been doing its part toward re­
straining excessive growth since last November. While it
might be contended that the Federal Reserve started re­
straining some months too late, there were im portant in­
hibiting factors last summer and autumn, including the
fear of damaging the prospects of tax legislation, the risk
of pushing sterling over the brink, and the reluctance to
make the Treasury’s huge financing program any more
difficult than necessary. In any event the tightening that
has been accomplished since November, and more espe­
cially since February, has been very sizable. Our re­

strictive program made use of all three of the major credit
policy instruments, i.e., open market operations, discount
rate increases, and higher reserve requirements. Last
m onth’s discount rate increase was the third Vi per cent
upward move since November, and the current rate of
5 V2 per cent is the highest discount rate in effect since
Naturally we are aware that a restrictive credit policy
bears unevenly on various sectors of the economy, with
housing and municipal financing usually feeling the pinch
more than other sectors. The Federal Reserve has cer­
tainly had to move further and faster than would have
been necessary if an appropriate fiscal program had been
enacted. As credit tightens and interest rates move up to
levels that are historically very high indeed, our financial
institutions come under growing pressure and the process
of disintermediation becomes clearly visible. The Federal
Reserve System must remain on the alert to see that these
pressures do not become too extreme, as they did in the
summer of 1966. We have no wish to see repeated the
highly nervous m arket atmosphere of that summer, nor
have we any wish to see an end to the growth of bank
The System’s ultimate goal insofar as credit growth is
concerned is a moderate rate of expansion in keeping with
a sustainable noninflationary growth of the economy. R e­
cent months have shown an encouraging slowdown in
credit growth, but maintenance of firm restraint seems
needed to keep this slower pace in the light of heavy and
growing credit demand, including resumption of large
Treasury borrowing. Fortunately the banks and thrift in­
stitutions are in a considerably better liquidity position
than they were two years ago, and this should make much
easier our efforts to avoid excessive m arket reaction.
Beyond the immediate need for strong support from
fiscal policy to reduce the fever of our overheated econ­
omy, looms the need for a return to the conditions of
price stability that characterized the earlier years of the
current business expansion. One of the important reasons
for price stability during that period was the record of
matching wage and productivity gains. It has become
fashionable to be contemptuous of the wage-price guideposts of that period, and to condemn them as unworkable,
The truth, however, is quite clear: it is any substantial
deviation from the principle of the guideposts that is un­
workable. We must keep off the primrose path that leads
to rigid wage, price, and dividend control or freeze; and
this means all of us— government, business, and labor—
must agree on some acceptable compromise that satisfies
us that no one else is going to obtain undue advantage at
our expense. A great virtue of the wage-price guideposts


was that they promised to help all Americans understand
the great difference between real gains and the mirage
benefits of inflation-swollen current dollars. In a demo­
cratic society, that kind of understanding, together with
freedom of labor and capital to respond to shifts in de­
mand, is much to be preferred to a harness of direct
To me these anti-inflationary measures of fiscal and
monetary policies and of wage-price guideposts represent
a prerequisite for balance-of-payments equilibrium. In this
connection, I would like to say a word about strikes that
have a major impact on our balance of payments. As one
looks back to last year it becomes clear that the London and
Liverpool dock strikes dealt a crushing blow to the pound
sterling. In our own country, it has been distressing to see
the hundreds of millions of dollars’ cost to the balance of
payments of the copper strike and the hedging against a
possible steel strike. Surely the nation has a right to ask
that leaders in both management and labor consider care­
fully the international payments effects of such strikes on
the dollar’s position.
There are many additional avenues to be explored, with
a view to improving our balance of payments. For example,
it may be that more could be done both by Government
and by the sophisticated business community to increase
the interest of small- and medium-sized American concerns
in developing an export market. While the Government has
done much to facilitate and encourage larger portfolio in­
vestment by foreigners in American securities, especially
in American equities, more could probably be done in this
area. O ur stock market already has a very strong appeal
throughout the world, but despite recent statutory action
there are still too many technical barriers to the translation
of this appeal into actual investment.
It goes without saying that the President’s balance-ofpayments program of January 1 should enjoy the full sup­
port of the nation, although most of us would have serious
qualms about more than temporary reliance on restraints
on the outward flow of American capital. I would remind
you that the effort to slow the flow of direct investment
should be viewed against the background of an unprecedentedly high level of direct investment outflow in 1965
and 1966. There is also much that surplus countries can do
to aid our efforts at achieving international equilibrium both
by their general economic policies and by their specific
actions affecting the balance of payments, but primary
responsibility falls on us.
Aside from our efforts to improve the trade surplus by
stemming inflation, the most hopeful area for further
balance-of-payments savings is that of Government ex­
penditures abroad. I am not suggesting ill-considered cuts


in foreign economic aid, for such outlays— subject of course
to careful screenings— are essential if we are to build the
kind of prosperous and peaceful world economy that is
vital to our own national well-being. As to Vietnam, there
are many reasons for hoping for a satisfactory end to the
hostilities. On the financial side, it would put an end to the
tremendous drain on our balance of payments that now
results, directly or indirectly, from our military outlays in
that area. It would be too much to expect equilibrium in
our international payments simply because of an end to the
war, but it would certainly bring a major improvement.
But apart from the specific Vietnam problem, we must
face squarely the question of whether the benefits arising
from military and political commitments abroad outweigh
their balance-of-payments cost. Some hard questions have
to be answered, and answered promptly. For example,
should not those European allies who stress the impor­
tance of having American troops in Europe assume a
larger part of the cost? If they are unwilling to do so, are
the benefits of maintaining these forces at our own expense
worthwhile in view of the substantial burden placed on
the dollar? M ore generally, we must bear in mind the fact
that the costs of military and political commitments may
include sacrifices in the form of even higher taxes at
home, intensified direct controls over capital movements,
and restrictions on tourism. Indeed, we have reached a
critical point at which the financial consequences of mili­
tary and political commitments must be weighed carefully
whenever decisions are made to initiate or continue such
commitments. I am not suggesting that financial considera­
tions should receive top priority, but merely that the finan­
cial side deserves a lot more weight than it has had in the
past. Further, and I think this needs the greatest possible
emphasis, there is now a grave risk that continuation of
our balance-of-payments deficit— by undermining the dol­
lar internationally— may in itself endanger world stability
and frustrate our ability to achieve our international eco­
nomic, political, and military goals.
Fortunately, we are not faced with an acute exchange
crisis at present. Nevertheless we must recognize that in
a more fundamental sense the dollar is— and for some
time will be— in a condition of crisis. This condition will
persist until we can show real progress toward payments
equilibrium. And, as I have tried to suggest, real progress
is not an impossible task if we take the necessary measures
to reduce economic overheating and to restore our com­
petitive position in world trade. I fervently hope that we
shall not need a recurrence of the black prospects of that
mid-March weekend to make us take those sound and
sensible steps that are clearly required to meet the chal­
lenge to the dollar in this rapidly changing world.



T he Business Situation
The first three months of 1968 saw a record— and
clearly excessive— advance in the dollar value of outlays
for goods and services in the United States. Substantial
further increases in market prices were partly responsible,
but even after adjustment for price changes total output
advanced almost 6 per cent at an annual rate, much above
the 4 per cent or less that is considered sustainable at full
employment. Buoyant consumer demand was the major
factor in the overall gain, but most other spending cat­
egories also increased. The pronounced caution that con­
sumers had exhibited throughout 1967 appears to be
diminishing, as evidenced by a marked drop in the personal
savings rate from 7.5 per cent of income in the final quarter
of last year to 6.8 per cent.
Against this background of rapidly expanding aggregate
demand, prices— already under heavy pressure from rising
wages and other costs— continued their sharp advance. The
gross national product (G N P) deflator, which is the broad­
est measure of price trends in the economy, rose at a 4 per
cent annual rate in the first quarter of 1968, going beyond
the already excessive increases of the previous two quarters.
The size, persistence, and widespread nature of these
price advances raise the threat of a major inflationary spiral
unless fiscal measures are undertaken to reduce substan­
tially the economic stimulus now being provided by a huge
Federal deficit.

According to preliminary estimates, GNP rose in the first
three months of the year by a record-breaking $20.0
billion (see Chart I) to a seasonally adjusted annual rate
of $827.3 billion. This economic expansion, which
amounted to 9.9 per cent at an annual rate, included a
5.9 per cent increase in physical output and a 4.0 per
cent jump in average prices. The gain in real output was
the highest since early 1966, and the price inflation was
the sharpest in more than a decade.
Consumer spending was a major factor in the steep rise
of GNP during the first quarter. Such spending swelled by a

record $16.0 billion, compared with an average quarterly
rise of only $7.0 billion during all of 1967. The increase
was due both to a rapid advance in disposable income and
to consumers’ willingness to spend a greater portion of
their income. Disposable incomes rose by a near-record
$13.8 billion, helped in part by the February increase in
the minimum wage and the M arch rise in social security
benefits. At the same time, the savings rate, which had
been running at an unusually high level since the end of
1966, dropped from 7.5 per cent of disposable income in
the fourth quarter to 6.8 per cent. Taken by itself, the
decline in the savings rate accounted for about $3.8 bil­
lion of the $16.0 billion increase in consumer spending.
Consumer demand ended the first quarter on a strong
note. Following sizable gains in retail sales in both January
and February, preliminary figures indicate that sales in
March posted another large advance, rising by $0.5 bil­
lion to $28.0 billion. Further, recent surveys of consumer
spending plans tend to support the view that consumer
optimism and buying interest are on the upswing.
Roughly half of the first-quarter advance in consumer
spending was in the nondurables component, where price
increases— notably for food and apparel— were substantial.
In the durables sector, spending was boosted by a rapid
advance in sales of furniture and new cars. Furniture sales
were sluggish throughout 1967 because of reduced home
purchase and rental, stemming from the previous year’s
slump in residential construction. With the recovery in the
housing sector, an improvement in furniture sales was not
surprising. Sales of domestically produced cars increased
to a seasonally adjusted annual rate of 8.2 million in the
January-M arch period, up 10.2 per cent from the strikereduced pace of 7.4 million units in the fourth quarter.
A t the same time, there was a strong upsurge in imports of
foreign cars. While domestic sales of foreign-built cars have
been rising in the last five years, the trend accelerated
markedly in recent months, perhaps owing in some degree
to the price increases on domestically produced cars. Dur­
ing 1967, imports claimed over 9 per cent of the United
States market— within striking distance of the 1959 high of
10.2 per cent. In the first quarter of this year, moreover,


C hart I

Season ally ad justed

C h an g e from third q u a r t e r

C h a n g e from fourth q u a rte rl 967

to fourth q u a rte r 1967

to firs tq u a rte r1 9 6 8


In ven to ry in vestm ent

Final expenditures

C onsum er expen d itures for
d u ra b ie g o o d s
C o n su m erexp en d itures for
n o n d u ra b le g o o d s
C on su m erexp en d itures for

R esidential construction

Business fix e d investm ent

F ed eral G overn m en t purchases

S tate an d local governm ent

N e t exp o rts o f g o o d s a n d
se rv ic es







Billionsof dollars

United States DepartmentofCommerce.

sales of foreign-buiit cars ran at a seasonally adjusted an­
nual rate of 1 million units— up over 40 per cent from the
first three months of last year.
The first-quarter surge in consumer spending apparently
cut heavily into the buildup of business inventories, espe­
cially at the retail and wholesale level. Due partly to this
factor, inventory spending by all business declined to a
$3.9 billion annual rate during the quarter, down $5.3 bil­
lion from the preceding quarter. But, while accumulation in
the trade sector lessened, manufacturers added to their total
inventories at a relatively strong pace during the quarter,
in part because of the buildup in steel and auto stocks.
Both business fixed investment outlays and residential
construction spending increased during the quarter. The
$3.2 billion advance in business fixed investment was the
largest since the final quarter of 1965 and confirmed
survey expectations of an upturn in the growth of capital
spending this year. Moreover, the most recent survey of
plant and equipment spending plans, taken by McGraw-


Hill, Inc., in M arch, indicates that businesses have revised
their 1968 capital spending plans upward to a level 8
per cent above that spent last year. The sizable fourthquarter increase in corporate profits— the first substantial
advance since the fourth quarter of 1965— had strength­
ened the outlook for plant and equipment spending, and
early indications are that corporate profits expanded still
further in the first quarter of 1968. In the housing sector,
spending rose to a record $28.3 billion annual rate, up
$0.7 billion from the final quarter of last year. D ata on
recent housing starts, building permits, and contract awards
for residential construction suggest that spending should
continue at a high rate in the next few months. Despite
some tightening of the home mortgage market, both hous­
ing starts and permits were little changed in M arch from
the high February pace and new residential construction
contract awards jumped 9 per cent over the February level.
Moreover, the low vacancy rates in existing structures con­
tinue to indicate a strong potential demand for new homes.
In the public sector, total Federal and state and local
government purchases of goods and services climbed by
$5.8 billion in the first quarter— the largest increase in a
year. The rise was chiefly due to a $2.4 billion gain in de­
fense spending and a $2.4 billion rise in expenditures by
state and local governments. The defense increase followed
two quarters of small advances, whereas state and local
spending was in line with the strong and steady upward
trend in that sector.
The strong pull of aggregate demand and the strike by
New York longshoremen in M arch further weakened the
trade surplus in the first quarter, and net exports declined
again. While exports advanced during the quarter, rising
purchases of foreign-produced steel, copper, automobiles,
machinery, and civilian aircraft parts contributed to a more
than offsetting increase in total imports. Based on data for
January and February alone, the Commerce Departm ent
had estimated that net exports in the first quarter declined
to an annual rate of $2.6 billion, the lowest since the first
quarter of 1960. Moreover, this figure is expected to be re­
vised lower when the M arch results are incorporated. In
March, when the Port of New York was struck for eleven
days, the merchandise trade balance, as recently reported
by the Census Bureau, actually registered a small deficit,
the first time this has occurred in five years.

The Federal Reserve Board’s index of industrial pro­
duction advanced for the second consecutive month in
March. Output rose 0.6 percentage point to a record 162.1



per cent of the 1957-59 average. Gains were widespread,
but were centered in the automotive and steel components.
Production of m otor vehicles and parts jumped 5Yi per
cent in M arch, following two months in which output had
been adversely affected by local labor disputes. Passenger
car production climbed by over 9 per cent to a seasonally
adjusted annual rate of 8.9 million units. In April, however, the civil disorders following the assassination of Dr.
M artin Luther King, Jr., curtailed production early in the
month, and initial indications are that output fell 3 Vi per
cent to a rate of 8V2 million units. Iron and steel produc­
tion rose again in March, as buyers continued to hedge
against a possible steel strike this summer. According to
preliminary figures, steel output in April gained fully 6 per
cent over the M arch level, reaching an all-time record of
12.7 million tons at a seasonally adjusted monthly rate.
Production increases in most other industries were small
in March, but coal output jumped by 10 per cent from the
strike-reduced pace of January and February.
The near-term outlook for production was bolstered
somewhat by the rise in new orders received in M arch by
manufacturers of durable goods. On the strength of a big
increase in orders for civilian aircraft, new orders rose
$1.3 billion to $26.1 billion. Among other durables m anu­
facturers, the flow of new orders generally continued at a
high rate. Shipments by durables manufacturers rose $0.5
billion in M arch to $25.2 billion, and because the advance
in shipments was less than the rise in orders, the backlog of
unfilled durables orders rose for the second month, reach­
ing a new record of $80.3 billion.
Recent increases in manufacturing production, although
substantial, have trailed overall GNP growth. Moreover,
manufacturers in general still report some excess plant
capacity. Plant and equipment spending has continued at
a high level, and new production facilities are being brought
on line at a fast clip. These additions to plant capacity,
coupled with the weakness in production during 1967,
brought about a substantial decrease in capacity utiliza­
tion rates. Although manufacturing production rose at an
annual rate of about 5 per cent in the first quarter, the
growth in capacity is estimated to have outstripped this
increase, and the overall capacity utilization rate edged off
by 0.3 percentage point to 84.1 per cent. (The preferred
operating rate in manufacturing is usually judged to be
around 90 per cent.)
In contrast to current utilization rates, developments in
the labor market continue to highlight the fact that labor
is now a critical factor limiting further expansion of real
output. Following a large February increase, nonagriculturai employment rose in M arch by 143,000 to a level
of almost 68 million. Gains were centered in public and

private services and in the trade sector. Advances in some
manufacturing categories were offset by additional layoffs
due to the glassblowers’ strike. The civilian labor force
eased slightly during the month, but the increase in em­
ployment resulted in a 0.1 percentage point decline in the
overall unemployment rate to 3.6 per cent. Although teen­
age unemployment rose, the unemployment rates for both
adult men and adult women fell. A t 2.2 per cent of the
labor force, adult male unemployment was equal to the
lowest rate since 1953.

The price situation deteriorated further in the first three
months of the year (see Chart II.) A steep escalation
in wage costs in a tight labor m arket and rapidly rising

C h art 1

P ercen t

P e rce n t

Note: The GNP deflator is plotted on a quarterly basis. All other d ata are monthly.
W holesale prices for April are prelim inary.
Sources: United States Departmentof Laborarid Department of Commerce.


prices at the wholesale and retail levels have become major
threats to the orderly growth of the economy. During the
1961-65 phase of the expansion, prices and costs rose on
average at a fraction of the recent rates of increase. The
GNP deflator moved up at an average annual rate of 1.5
per cent in those five years. Industrial wholesale prices
averaged annual increases of 0.4 per cent, and consumer
prices— reflecting mounting service as well as other costs—
advanced at an average yearly rate of 1.4 per cent. A t the
same time, labor costs per unit of output actually declined
by an average of 0.3 per cent per year, as productivity grew
faster than wages. The overheating of the economy in 1966
changed all this, however. Prices in that year moved up
sharply in response to excess demand, while depressed agri­
cultural production accentuated the rise in food prices. Then
in 1967 cost pressures, inherited partly from the demandpull inflation in 1966, pushed prices up on all fronts,
particularly in the last half of the year when demand con­
ditions began to improve. Thus, the GNP deflator rose 3.0
per cent in that year even though demand pressures were
generally moderate. Industrial wholesale prices turned up
sharply last summer, after virtual stability in the first half
of the year, and increased 1.8 per cent over 1967 as a
whole. In manufacturing, unit labor costs— reflecting strong


competition in the labor markets, increasingly large nego­
tiated wage settlements, and slow productivity growth—
climbed 4.0 per cent last year, and consumer prices rose
3.1 per cent.
In the first three months of this year, price advances con­
tinued to accelerate. The GNP deflator increased at an
annual rate of 4.0 per cent, and by the end of the quarter
industrial prices had soared at an annual rate of 4.5 per
cent over the December level, although preliminary figures
suggest that this upward trend moderated a bit in April.
Wage costs increased even more than other price trends.
Higher wage rates and other labor costs, such as the in­
creased social security contribution required of employers,
combined with lagging productivity gains to push labor
costs per unit of output up at an annual rate of fully 10.1
per cent in the first three months of the year. Reflecting
this broad upward movement, consumer prices advanced
at an annual rate of 4.4 per cent in the quarter, and in
M arch the index rose at a yearly rate of 5.0 per cent.
Against this background of rising wage costs, a tight labor
supply, and the recent increases in industrial wholesale
prices, the first-quarter surge in consumer demand adds
further to the likelihood that consumer prices will rise
sharply in the coming months.

T he M oney and Bond M a rk e ts in A p ril
Short-term interest rates continued to climb during April,
under the impact of sustained pressure on member bank
reserve positions and further moves by the Federal Reserve
System to restrain inflationary forces in the economy and
to strengthen the position of the dollar. On April 18, the
Board of Governors of the Federal Reserve System an­
nounced that it had approved increases in the discount
rates of the Federal Reserve Banks of New York, Phila­
delphia, and Minneapolis to 5Vi per cent from 5 per cent,
effective the following day. A t the same time, the Board
announced the adoption of a liberalized schedule of max­
imum interest rates payable by member banks on largedenomination negotiable certificates of deposit (C /D ’s),
with ceiling rates scaled upward from 5 V2 per cent on the

shortest maturity category to 614 per cent on the longest.
In the next week, similar discount rate action was
taken by the other nine Reserve Banks.1 Immediately fol­
lowing the initial moves by the System, large commercial
banks across the country raised their prime lending rate—
the minimum rate charged on loans to the largest and
best-rated business borrowers— to 6 V2 per cent, and
m ajor money m arket banks in New York City and outside

1 The discount rate increase became effective on April 19 at the
San Francisco Reserve Bank, on April 22 at the Atlanta Reserve
Bank, on April 23 at the Boston and St. Louis Reserve Banks,
and on April 26 at the remaining five.


Table I

Table II


APRIL 1968

In millions of dollars; ( + ) denotes increase,
(— ) decrease in excess reserves

In m illions of dollars
Daily averages--week ended on
Factors affecting
basic reserve positions

Changes in daily averages—
week ended on




“ Market” factors


4- 20
4- 29
4 - 160



— 220
— 153
4 - 307
— 192
4 - 45
— 289
— 25

— 68



— 373


— 274
- f 188
+ 22

— 539
4- 167


— 544
+ 47

— 164

Other Federal Reserve accounts (n et)$..


— 156



Direct Federal Reserve credit

Open market instruments
Outright holdings:



-f- 31G




4 - 66
— 49
— 2
4- 117


— 25

4 - 306
— 1

Repurchase agreements:

Federal agency obligations ..................
Other loans, discounts, and advances----Total ..............................................................
Excess reserves* ...................................................

-j- 164
— 3
+ 114 j
— |




— 260
— 14
— 7
— 112

4 - 279

4 - 134

— 418 |

+ 169 | - f 123

4- 66

— 403

+ 333




Eight banks in New York City


Operating transactions (subtotal)..............




Averages of
four weeks
ended on
April 24*

— 46
4- 69
4 - 328


Reserve excess o r deficiency(—)t- j
Less borrow ings from
Reserve Banks ........................................
Less net interbank F ederal funds
purchases or sales(—) .........................
Gross purchases . . . . . . . . . . 950 . 1,479 . 1,726. . 1,466. . . 1,405 . . .
. .
. . .
. .
. .
. .
Gross sales
. . . . . . . . . .514 . . 348 . . 515 . . 793. . . . 543 . . . . . . . .
. .
. .
Equals net basic reserve surplus
—1,137 —1,259 — 729
or deficit(— ) ....................................... — 418
— 886
N et loans to G overnm ent
securities dealers ..................................

Thirty-eight banks outside New York City
R eserve excess or deficiency(—) t...
Less borrow ings from
Reserve B anks ......................................
Less net interbank F ed eral funds
purchases or sales(— ) .........................
. . .
. .
. .
. .
. .
Gross purchases . . . . . . . . . 1,603 . 1,910. . 2,018. . 2,298. . . 1,957 . . .
Gross sales
. . . . . . . . . 1 J 4 7 . . 1 ^. 8 7 . .1,134 . 1,107 . . 1,194. . . . . . . .
. .
. .
. . .
. .
E quals net basic reserve surplus
or deficit(— ) .......................................... — 622 — 650 —1,258 — 1,453
— 996
N et loans to G overnm ent
securities dealers .................................
N ote: Because of rounding, figures do n o t necessarily add to totals.
* E stim ated reserve figures have no t been adjusted for so-called “ as o f”
debits and credits. These item s are taken into account in final data,
t R eserves held after all adjustm ents applicable to the reporting period less
required reserves and carry-over reserve deficiencies.

Table III

Daily average levels

In p e r cent
Member bank:
Total reserves, including vault cash*........
Required reserves* ........................................

Nonborrowed reserves* ..................................

— 366

— 193

— 244

— 535

355 §
689 §
— 334 §
24,937 §

Weekly auction dates— April 196S

Changes in Wednesday levels






T hree-m onth .....................................



: 5.568

! 5.689

^ 5.612






Monthly auction dates— February-April 1968


System Account holdings of Government
securities maturing in:
4- 676
4- 128

— 424

Total ..........................................................

4 - 804

— 424



— 896

— 185



N ine-m onth.......................................









— 322
4- 137


Note: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated,
t Includes changes in Treasury currency and cash.
t Includes assets denominated in foreign currencies.
§ Average of four weeks ended on April 24.

— 905
4nr 9


O ne-year............................................

Less than one year..........................................
More than one year..........................................



* Interest rates on bills are quoted in term s of a 360-day year, with the discounts
from p a r as the return on the face am ount of the bills payable at m aturity.
B ond yield equivalents, related to the am ount actually invested, w ould be
slightly higher.


posted higher offering rates on new C /D ’s.
While nationwide net reserve availability averaged about
the same in April as in March, the reserve positions of the
m ajor money market banks in New York City deteriorated
sharply, and most Federal funds trading took place at 53
or 5% per cent, compared with 5V4 to 5 Vi per cent in the
latter half of March. During the three statement weeks
ended on April 17, covering the income tax date and pre­
ceding the increase in the Regulation Q ceiling, the city
banks experienced a C /D attrition of $503 million,
substantially greater than the $186 million attrition in the
comparable period of M arch which also included a tax
date. After the M arch 31 quarterly statement date, banks
liquidated Treasury bills in volume, so that bill rates came
under strong upward pressure early in April. They were
marked up further after an announcement by the Treasury
of an addition to its weekly auction of six-month bills,
and still further after the discount rate increase. The latter
action also prompted increases in rates on bankers’ ac­
ceptances, finance company paper, prime commercial pa­
per, and Euro-dollars.
In contrast to the pronounced upward trend of short­
term interest rates, yields rose only slightly on intermediateterm issues and declined moderately on long-term Treasury
securities during April. Prices of Treasury coupon issues
rose sharply at the beginning of the month after President
Johnson announced on M arch 31 that he had ordered a
limitation of the bombing of North Vietnam and was seek­
ing early peace negotiations. However, price gains were
limited by increasing disappointment in the m arket over the
delay in reaching agreement on a site for peace talks and
over the failure of the Congress to act affirmatively on a tax
increase. The announcement of increases in the discount
rate and in the Regulation Q ceiling on April 18 caused a
sharp markdown of prices, but revived hope of peace nego­
tiations and tax action served to steady the m arket later.
However, the approach of the Treasury’s May financing
was a restraining influence on prices. Similarly, in the m ar­
kets for corporate and tax-exempt bonds, an atmosphere of
buoyancy early in the period was later replaced by one of
hesitancy and caution, and yields established on new offer­
ings rose.

Average net borrowed reserves of member banks
amounted to $334 million during the four statement weeks
ended in April (see Table I ) , only moderately higher than
the $311 million average (revised) in the four statement
weeks of March. Net reserve availability varied widely
within the period, however, with average net borrowed


reserves easing to the $200 million level in the second
and third statement weeks and deepening to $535 million
in the final week of the month.
The money market was continuously firm during April,
and Federal funds were generally quoted at a substantial
premium over the prevailing discount rate. This premium
rose as high as % percentage point at the start of the
month, when the major money market banks in New York
City began to feel the effects of a marked deterioration in
their basic reserve position. The average basic reserve
deficit of the forty-six reporting money market banks
mounted to more than $2.5 billion in the week of April 17
(see Table II) from $0.7 billion in the final week of March,
reflecting the continuing heavy financing needs of dealers in
United States Government securities and an increased de­
m and for business and sales finance company loans. In the
statement week of April 17, moreover, the city banks,
along with banks elsewhere in the country, sustained a
sharp loss of C /D ’s as maturities around the income tax
date were not renewed. Prior to the increase in the discount
rate, rates charged by the city banks on new call loans to
Government securities dealers were quoted at about 6 to
6 Vi per cent, compared with 5 Vi to 53 per cent in late
March (see chart). Money m arket rates moved generally
higher following the increase in the discount rate. L ater in
the statement week ended on April 24, however, conditions
tended to ease temporarily, mainly because of the release of
accumulated excess reserves by the “country” banks. In
that week, moreover, the basic reserve position of the
money market banks improved, largely because of a rapid
repayment of business loans and a sharp decline in the
financing needs of dealers in United States Government
securities. A t the end of the month, however, pressures in
the money m arket intensified; the effective rate for Federal
funds rose to 6V4 per cent, the highest since November
1966, and new call loans to dealers were quoted at 65 to
63 per cent.
Under the new schedule of maximum rates of interest
payable on C /D ’s, rates of 5% per cent may be offered
on 60- to 89-day maturities, 6 per cent on 90- to 179-day
maturities, and 6V4 per cent on maturities of 180 days or
more. The 5 Vi per cent ceiling, which had previously
applied to all maturities, continues in effect for maturities
of 30 to 59 days. Immediately after the ceilings were lifted,
the money m arket banks in New York City raised their
posted offering rates on new C /D ’s maturing in 90 days or
more to 5% per cent, and a rate of 6 per cent was posted
by the end of the month. The new C /D offering rates posted
at the end of April compared with dealer offering rates of
5% per cent on 90-day unendorsed bankers’ acceptances
and 6 per cent on prime four- to six-month commercial



paper, with a published offering rate of 5% per cent on
directly placed finance company paper maturing in 30 to
270 days and with a bond equivalent yield of 5.88 per
cent on six-month Treasury bills.
During the statement week ended on April 24, the
weekly reporting banks in New York City gained $184
million through an increase in large C /D ’s, after having lost
$359 million through C /D runoffs in the preceding week.
At large commercial banks throughout the country, the net
contraction of C /D ’s in the April 17 statement week
amounted to $697 million, a substantial proportion of the
$1,243 million that had been scheduled to mature on the
April 15 tax date. In the following statement week, how­
ever, C /D liabilities of these institutions rose by $286 mil­
lion, in response to the higher issuing rates posted subse­
quent to the increase in the Regulation Q ceiling.

Prices of Treasury notes and bonds rose sharply during
the first three days of April, in reaction to the speech by
President Johnson on M arch 31 announcing a halt in the
bombing of much of North Vietnam and calling for peace
negotiations, and to subsequent indications that this deescalation move had met with a favorable response from
the Hanoi government. The coupon market was further
strengthened by news that the United States Senate, on
April 2, had approved legislation providing for a 10 per
cent income tax surcharge and a $6 billion reduction in
Federal Government spending. Optimism in the market
soon faded, however, as progress toward peace negotiations
was stalled by the failure of the Washington and Hanoi
governments to reach agreement on a site for the talks,
and as further consideration of income tax legislation by
the Congress was postponed until after the Easter recess.
Moreover, m arket participants began to reflect that the
Vietnam negotiations might be quite lengthy and that even
a total cessation of hostilities in Vietnam would not bring
about an immediate sizable reduction in defense spending.
They saw further cause for concern over the outlook for
intermediate- and long-term yields in the recent resur­
gence in the demand for business loans at commercial
banks, in the sizable calendar of new corporate financing,
and in increasing evidence of strong monetary restraint.
As midmonth approached, in fact, there was growing spec­
ulation about an increase in the commercial bank prime
lending rate.
After the announcement of the discount rate increase on
April 18, prices of Treasury coupon issues were marked
down sharply. Over the remainder of the period, however,
prices fluctuated irregularly, mainly in response to varied

news reports regarding the outlook for peace negotiations
and for enactment of income tax legislation. Activity was
limited, as participants awaited an announcement of the
terms of the Treasury’s refunding of May maturities ex­
pected near the month end. (The Treasury announced on
May 1 that it was offering at par a 6 per cent seven-year
note in exchange for the 4% per cent note and 3% per
cent bond maturing on May 15. The maturing issues total
$8 billion, approximately $3.9 billion of which is publicly
held. Additionally, the Treasury announced a concurrent
offering for cash of about $3 billion of a fifteen-month note,
priced at par to yield 6 per cent. The payment and delivery
date for both of the new issues is May 15.)
Rates on Treasury bills rose substantially during April,
attaining their highest levels since the fall of 1966. The
news of a reduction in hostilities in Vietnam produced
only a limited markdown in bill yields on the opening
day of the period. Over the first half of the month, rates
tended to rise in response to aggressive selling by com­
mercial banks meeting increased pressure on their reserve
positions and by dealers attempting to reduce inventories
in the face of substantially higher financing costs. On April
11, rates were marked up sharply after an announcement
by the Treasury that the size of the regular weekly offering
of six-month bills would be increased by $100 million.
Around midmonth, however, the m arket firmed in re­
sponse to the reappearance of investment buying. Demand
was strong from public funds and other investors, including
holders of April tax anticipation bills who redeemed for
cash bills not tendered in payment of income taxes. Fre­
quently such demand encountered a thin supply of offer­
ings. Bill rates were adjusted roughly 20 to 30 basis points
higher on April 19, when increases in the discount rates of
four Reserve Banks and in the Regulation Q ceilings on
C /D ’s became effective.
Bidding in the regular weekly auctions of three- and
six-month bills was unenthusiastic in the first two auctions
held during the month, but was quite aggressive in later
auctions at the higher rate levels after investment buying
reappeared. In the auction held on April 15, the first in
which the additional $100 million of six-month maturities
was offered, bidding resulted in average issuing rates of
5.46 per cent and 5.57 per cent for the three- and sixmonth issues, respectively, 15 and 17 basis points higher
than corresponding rates established in the preceding weekly
auction (see Table II I). Issuing rates rose further in the
next auction, but tapered off in the final weekly auction of
April. In the regular monthly auction of longer bill m a­
turities held at the end of April, the nine-month and oneyear bills were awarded at average issuing rates of 5.67
per cent and 5.66 per cent, respectively, 24 and 19 basis



F e b r u a r y - A p r il 1 9 6 8


F e b ru a ry

M a rc h

A p ri I


F e b ru a ry

M a rc h

A p r il

Note-. D ata are shown for business days only.
M O N EY MARKET RATES QUOTED: D oily range of rates posted by major New York City banks

point from un derw riting syndicate reoffering yield on a given issue to m arket yield on the

on new call loans (in Federal funds) secured by United States G overnm ent securities (a point

same issue im m ediately after it has been released from syndicate restrictions); d a ily

in dicates the absence of any range); offering rates for directly placed finance company paper;

averages of yields on long-term Governm ent securities (bonds due or calla b le in ten years

the effective rate on Fed eral funds (the rate most representative of the transactions executed);

cr more) and of G overnm ent securities due in three to five years, computed on the basis of

closing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month

closing bid prices; Thursday averages of yields on twenty seasoned tw enty-year tax -ex e m pt

Treasury bills.

bonds (carrying M oody's ratings of A a a , A a, A, and Baa).

BO ND MARKET YIELDS QUOTED: Yields on new A a a - and A a-rated public utility bonds are plotted
around a line showing d a ily averag e yields on seasoned A a a -ra ta d corp o rate bonds (arrows

points above rates established on comparable offerings in
the M arch auction.
In the m arket for Federal agency securities, a $445
million issue of nine-month debentures of the Federal in­
termediate credit banks, originally intended to be offered
just before the discount rate increase, was postponed until
April 24, when it received an excellent m arket reception
at a yield of 6.10 per cent. On April 17, the Export-Im port
Bank of the United States, for the first time, began selling
short-term discount notes in order to obtain supplemental
funds for its various export programs. Maturities of the
notes, ranging from 30 to 360 days, are selected by inves­
tors with the approval of the agency. The Attorney Gen­
eral has ruled that contractual obligations of the ExportIm port Bank are general obligations of the United States.

Sources: Federal Reserve Bank of N ew York, Board of Governors of the Federal Reserve System,
M o o d y’s Investors Service, and The W e e k ly Bond Buyer.


Prices of corporate and tax-exempt bonds moved sharply
higher at the beginning of April in the wake of the an­
nouncement of new attempts by the Administration to seek
a negotiated settlement of the Vietnam war. Dealers’ in­
ventories of both corporate and tax-exempt debt issues were
reduced substantially: unsold balances of recent offerings
were quickly taken from dealers, and new issues being
m arketed at higher prices met a favorable response from
investors. As the month progressed, however, signs of in­
vestor resistance to the higher price levels became ap­
parent. A few issues were postponed, and one prospective
corporate borrower canceled an offering after obtaining
financing through a commercial-bank term loan.



After the discount rate increase, prices in the corporate
and tax-exempt markets weakened considerably. Illustrat­
ing the sharp change of sentiment in the corporate market,
a large issue of Aaa-rated long-term telephone bonds was
sold late in the month at a reoffering yield of 6.75 per cent,
whereas a comparable offering at the start of the period had
been successfully m arketed at a yield of 6.60 per cent. A l­
though many participants in the tax-exempt market were
hopeful that the increase in the Regulation Q ceiling would
provide some assurance of continued bank buying, more
apparently felt that the increase in monetary restraint tak­

ing place did not augur well for the m arket over the months
ahead. Thus, The Weekly Bond Buyer's average yield series
of twenty seasoned tax-exempt issues, which had declined
sharply from 4.54 per cent at the start of April to 4.29
per cent just prior to the discount rate and Regulation Q
actions, rose to close the month at 4.43 per cent. Over the
latter part of April, inventories of both corporate and taxexempt issues tended to accumulate in dealers’ hands. The
Blue List of dealers’ advertised inventories of tax-exempt
bonds climbed to $585 million at the month end, sub­
stantially higher than the $454 million at the end of March.

Banking and M on etary D evelopm ents in the First Q u arter of 1968
The growth of money and bank credit slowed further
in the first quarter of 1968 as the movement toward credit
restraint, which began in the closing months of 1967,
intensified. Dangerous stresses in the international mone­
tary system, resulting in large part from this country’s con­
tinuing balance-of-payments deficit, plus growing infla­
tionary pressures in the domestic economy necessitated
the coordinated use during the first quarter of all the
principal instruments of monetary policy. In mid-January,
reserve requirements on demand deposits in excess of
$5 million at member banks were increased by Vi per­
centage point, absorbing about $550 million of member
bank reserves. Then, on M arch 14, following un­
precedented speculative demand for gold abroad, the
Board of Governors of the Federal Reserve System an­
nounced approval of an increase in the discount rate from
AVi per cent to 5 per cent, effective the next day, at nine
Federal Reserve Banks.1 The new 5 per cent discount rate
was the highest in nearly four decades. (After the quarter
closed, monetary restraint moved a step further in April
with another increase in the discount rate to 5Vz per
ce n t.)2 Moreover, open m arket operations were adjusted

1 The Federal Reserve Banks of San Francisco and Philadelphia
posted increases in their rates effective on March 15 and 18, respec­
tively, while the Federal Reserve Bank of New York did not take
similar action until March 21, effective the following day.
2 For details, see page 95 of this Review.

progressively during the quarter to restrain further the
expansion of money and credit. As one measure of the
increasing restraint brought to bear on bank reserve posi­
tions, daily average free reserves declined steeply during
the quarter, dropping from an average of about $100 mil­
lion in the first weeks of the year to an average of minus
$310 million in March. A t the same time, the effective
rate on Federal funds increased sharply, rising from just
over AV2 per cent in early January to roughly 514, per
cent in late March.
The System’s move toward progressively tauter monetary
conditions was reflected in slower rates of growth in most
credit and liquidity indicators during the January-M arch
period. The growth of total commercial bank credit fell
to a seasonally adjusted annual rate of 6.8 per cent from
7.5 per cent in the fourth quarter of 1967, markedly below
the growth in 1967 as a whole. The rate of increase in the
money supply also slowed during the first three months
of this year, as did the growth of commercial bank time
deposits. A t the same time, nonbank thrift institutions ex­
perienced relatively modest growth in their deposits and
share capital.
The progressive tightening of money m arket conditions
was also manifested in upward pressure on m arket interest
rates. While yields on most short- and long-term Govern­
ment and private debt issues declined during the first part
of the quarter, they climbed thereafter as monetary re­
straint intensified and, for the most part, closed the quarter
at higher levels than those prevailing three months earlier.


Rates on short-term Treasury bills were relatively stable
until mid-March, when they rose in response to the in­
crease in Federal Reserve Bank discount rates. Yields on
intermediate- and long-term Government issues matched,
and in some cases surpassed, their 1967 peaks in midM arch and then declined slightly over the remainder of the
month. Corporate and tax-exempt bond yields continued
to climb throughout M arch, however, and tax-exempt yields
reached the highest levels in thirty-five years.
‘ B A N K C R E D IT

Although the rate of expansion of total commercial bank
credit moderated on balance in the first quarter of 1968
(see Chart I ) , the pattern of growth within the period was
highly uneven. In January and February bank credit in­
creased at annual rates of 10.8 per cent and 13.8 per cent,
respectively, while the final month of the period witnessed
a small decline. This extreme unevenness largely reflected
wide swings in holdings of United States Government and
other securities and in loans for the financing of securities

Chart I

S easonally ad justed a n n u a ! rates
P erce n t

P ercent






[jg] 1 96 1 -65



g g ] 1 967


ls tq u a r te r 1 9 6 8

Note: Changes are computed from levelson the last Wednesday of the month
before a n d a tth e e n d o fe a c h period.
Source: Board of Governorsof theFederalReserveSystem.


Bank holdings of Government securities rose sharply in
February, when banks were accorded full Tax and Loan
Account privileges in connection with the Treasury’s sale
during the month of $4 billion of new notes. However, a
large proportion of these securities was then distributed to
the nonbank public in M arch, and over the quarter as a
whole bank holdings of Government securities increased
only modestly. Even so, this slight gain did represent a
substantial turnaround from the fourth quarter of 1967
when Government securities were liquidated. On the other
hand, acquisitions during the first quarter of other securi­
ties— primarily tax-exempt issues— were at only half the
pace recorded in the final three months of 1967. This slow­
down about offset the greater relative strength in holdings
of Government securities, and total investments rose in the
first quarter at an annual rate of 7.9 per cent, only slightly
faster than in the fourth quarter and markedly below the
advance in 1967 as a whole. This modest advance un­
doubtedly reflected tighter monetary conditions and slower
deposit inflows in the January-M arch period.
Total commercial bank loans increased at a seasonally
adjusted annual rate of 6.4 per cent in the first quarter,
somewhat below the 8.5 per cent advance in the fourth
quarter of last year. Loans gained sharply in January,
moderately in February, and then actually declined slightly
in March. This pattern was influenced by sharp fluctua­
tions in securities loans. In January, sales of Federal N a­
tional Mortgage Association participation certificates and
tax anticipation bills swelled dealer inventories, giving rise
to substantial dealer borrowing at commercial banks. Se­
curities loans advanced again in February, though more
moderately than in January, as dealers borrowed at banks
to finance purchases of the Treasury notes issued just after
midmonth. The sharp drop in securities loans outstanding
in M arch was attributable in large part to a reduction in
dealer inventories, which was facilitated by the lack of
any significant Treasury financing during the month, and
was encouraged by the sharply higher rates charged by
banks on call loans to securities dealers. Indeed, call loan
rates were almost a full percentage point higher after
mid-March than they had been during most of January.
The demand for bank loans by business was relatively
modest in the first quarter as a whole, although a more ag­
gressive demand did emerge toward the end of the period.
Commercial bank loans to business increased at a season­
ally adjusted annual rate of 7 per cent in the JanuaryM arch period, substantially slower than the 10 per cent
rate of advance during the fourth quarter of 1967. Business
loan demand strengthened in March, however, even though
corporate income tax payments were roughly $2.5 billion
less than they were on the same tax date in the previous



three years. The M arch advance was broadly based, as busi­
ness activity expanded rapidly in most sectors of the econ­
omy. A strong surge in business loans after mid-M arch may
have reflected in part increased expectations that commer­
cial bank prime rates would rise following the discount rate
Construction activity remained strong in the first quarter,
and real estate loans held by banks expanded at an 11 per
cent annual rate, continuing the relatively rapid growth that
began in the second half of 1967. A t the same time, ex­
tensions of consumer credit by commercial banks also
advanced sharply, reflecting the record advance in con­
sumer spending during this period. The 13.7 per cent
annual rate of growth was twice the increase in the fourth
quarter of 1967 and represented the largest quarterly gain
in this loan category since the third quarter of 1965.

C h artli

S easonally ad ju sted a n n u a l rates


The rate of expansion of the daily average money supply
— privately held demand deposits plus currency outside
banks— continued to moderate in the first quarter, when
the annual rate of growth fell to 4.2 per cent from 5.1
per cent in the final quarter of 1967. The money supply
rebounded in January, after growing very slowly in De­
cember, but then remained virtually unchanged in February
as Treasury deposits in commercial banks swelled and
private deposits declined. (This inverse relationship be­
tween Treasury and private deposits often holds over short
periods of time.) In March, when Treasury deposits de­
clined, the money supply expanded once again.
The growth of daily average time deposits at commercial
banks fell sharply in the first quarter to an annual rate of
6.1 per cent, after an 11 per cent rise in the fourth quarter
of last year. In January commercial banks actually lost
time deposits, but inflows recovered in February and
M arch. The relatively slow growth in time deposits over
the quarter was attributable in large part to the weak per­
formance of large-denomination certificates of time de­
posit ( C /D ’s representing deposits of $100,000 or m ore).
A t weekly reporting banks, outstanding C /D ’s advanced by
$224 million during the first quarter, about half of the
previous quarter’s increase and far below the $3.6 billion
gain in the first quarter of 1967. Increases in January and
February were smaller than in the same months of the
previous year, and in M arch large C /D ’s fell sharply, de­
clining by $500 million during the tax week alone. The
relatively slow growth of C /D ’s in the first quarter resulted
largely from a $644 million net loss by large New York
City banks. Indeed, reporting banks outside New York
City recorded a net gain of $868 million over the quarter.

£ 3 1 961-65

S 3 1966




ls t q u a r t e r l9 6 8

Computed from daily average levels during the week prior to and
at the end of each period.
Computed from levels at the beginning and endof each period.

Source: Board of GovemorsoftheFederalReserveSystem.

However, large outflows were also experienced by these
banks in March, indicating the widespread difficulty in
rolling over maturing certificates. Although rates most often
posted on certificates of 180-day maturity or longer were
at the 5Vz per cent Regulation Q ceiling throughout the
quarter, and rates on shorter maturities were at the ceiling
before the end of the period, yields on alternative forms of
investment were becoming more attractive than the maxi­
mum allowable C /D rate.3
The ratio of loans to deposits at all commercial banks
increased slightly over the quarter as a whole, from an
average of 62.7 per cent in December 1967 to 63.1 per
cent in March. The ratio rose a full percentage point in
M arch, however, after declining in January and edging up
only slightly in February. The loan-deposit ratio at large
New York City banks, where C /D losses were substantial,

3 On April 18, the Board of Governors of the Federal Reserve
System announced increases in Regulation Q ceiling rates for most
maturities of large denomination C /D ’s. For details, see page 97
of this Review.


increased rather sharply during the quarter. Moreover,
these banks borrowed quite heavily from their foreign
branches during the January-M arch period, permitting
loans to expand relative to deposits.

Liquid assets held by the nonbank public increased at a
seasonally adjusted annual rate of 8.6 per cent during the
first quarter (see Chart I I ) , somewhat slower than the 9.3
per cent growth rate in the final quarter of 1967. The expan­
sion of deposits and share accounts at commercial banks,
mutual savings banks, and savings and loan associations
failed to keep pace with the growth of other liquid assets.
Deposits held by the nonbank public at thrift institu­
tions advanced at a seasonally adjusted annual rate of
6.6 per cent from December through March, slightly faster
than in last year’s fourth quarter but considerably slower
than the 9.1 per cent growth over 1967 as a whole. Both
m utual savings banks and savings and loan associations
experienced reduced growth in January, following year-

end interest and dividend crediting, but their growth rates
picked up in February and M arch.
The public continued in the first quarter to acquire
large amounts of Government securities m aturing within
one year, after having purchased $2.3 billion in the final
quarter of 1967. Indeed, holdings of these liquid assets
increased by $5.6 billion in the January-M arch period, a
larger gain than in the entire second half of the previous
year. Fully 40 per cent of the gain in total liquid assets
in the January-M arch period was accounted for by the in­
crease in short-term Government securities. Undoubtedly,
the high and rising yields on securities m arket investments
relative to deposit rates offered by commercial banks and
thrift institutions exerted an im portant influence on this
The relative liquidity of the nonbank public, as measured
by the ratio of total liquid assets to gross national product,
remained virtually unchanged in the first quarter. This
ratio was 79.4 per cent, slightly below the 79.6 per cent
of the previous quarter but equal to the average for the
year 1967.

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